The first rule of price setting
You need to get more money out of a sale than you put into it. Which means you need to know the cost of the goods sold (also known as cost of sales).
What is cost of goods sold (or services sold)?
Cost of goods sold, or COGS, tells you what your business spends to deliver a product or service to your customer. It’s treated differently to general costs like rent or employee wages.
Identifying what COGS is in your business
Look for expenses that:
- occur only when a service or good is provided
- go up and down as sales go up and down
You can get a good idea of your COGS by performing this calculation:
Some of the above costs may not apply
What are pricing strategies?
Now that you know your COGS, you know the minimum amount you have to charge to make money. But it helps to have a system to work out what you should add. That’s what a pricing strategy is.
Cost-plus pricing strategies
You can simply add a standard markup to everything you sell. Check if there are industry-standard markups, as they can give you a good place to start. An accountant or bookkeeper with experience in your industry will know.
Market-based pricing strategies
Check out the range of prices that your competition charges and:
- go higher if you offer more convenience or a premium experience
- match the average if you don’t want to turn off price-sensitive shoppers
It’s not a good idea to go low unless you have a steady supply chain and expect a lot of sales.
Some businesses bundle a few things together at a slight discount. Their profit margins come down but they sell more items as a result. Some market research will tell you what product combinations will work.
Launch pricing strategies
New products (or businesses) sometimes use temporary pricing strategies to try and grow their customer base. These include:
- Penetration pricing: where you lower margin to increase sales volume. This can attract new customers fast, but the trick is to keep them when your prices go up.
- Price skimming: where you hike prices on new products or services believing that enthusiastic early adopters will pay more. Then you drop prices later on.
- Sweetener deals: where you set prices high but offer introductory discounts. It allows you to create the feeling of a deal without permanently devaluing your product or service.
Pricing methods and COGS are key to profitability
You have two levers for making money in business – your margin and your sales volume. They’re both affected by price. So give lots of thought to what you charge.
Start by working out your COGS, so you know the least you need to make on a sale. And then use some of the pricing strategies outlined here to work your way toward a ticket price.
Accountants and bookkeepers can help a lot with the numbers. They will understand industry norms and can help tell if your margins are too thin.
Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.
How to start a business
Thousands of new businesses open every day. If all those people can do it, why not you? Here’s what to do, and when.
- How to do market research
Your business idea is clearly inspired. But it helps to check you’re not the only one who thinks so.
- How to write a business plan
Writing a business plan will help nail down your idea and give you a blueprint for executing it.
- Budgeting and forecasting
It’s time to run some numbers on your business idea. Budgeting and forecasting help with that.
- Pricing strategies and cost of goods sold
Your prices can influence the number of sales you make and the profit you earn on each transaction.
- Types of business structure
Your business structure can affect how much tax you pay, and how you're treated by the law.
- Small business accounting
If you’re starting a business, then you’ll need to get familiar with some accounting basics.
- Registering a business and other admin tasks
After all the excitement of deciding to start a business, you’ll have some paperwork to do.
- How to create a business website
Treat your website like an online version of a storefront. It’s the first impression for many customers and prospects.
- Tools and guides for your business
Now that you’re in business, you want to stay there. Xero’s got resources and solutions to help.
Download the guide to starting a business
Learn how to start a business, from ideation to launch. Fill out the form to receive this guide as a PDF.